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A mortgage is a loan from a bank or another lending institution that helps you buy a home. The lender provides funds on your behalf for your home purchase, and you agree to repay the loan plus interest. If you stop making monthly payments, your lender can repossess your home through the foreclosure process and sell it to recover their money.
There are several factors that determine your mortgage rate, including your:
Economic factors, such as inflation and U.S. Treasury bond yields, can also influence mortgage rates to move up or down.
One of the main ways to get your best mortgage rate is to improve your credit score before applying for a mortgage. Aim for a minimum 740 credit score, which may help you qualify for the lowest rates.
A lower debt-to-income (DTI) ratio can also lead to a lower rate. Your DTI ratio is the percentage of your gross monthly income used to repay debt. Lenders like to see a maximum DTI ratio of 43%, according to the Consumer Financial Protection Bureau.
A larger down payment and shopping around with multiple lenders are other ways to get your best rate.
The Federal Reserve’s monetary policy directly affects adjustable-rate mortgages, as they are tied to an index that moves up and down with the broader economy. The Fed’s policy indirectly impacts fixed-rate mortgages, which typically correlate with the 10-year U.S. Treasury bond yield.
You can compare mortgage rates by shopping around with multiple mortgage lenders. A good rule of thumb is to pick three to five lenders and gather quotes from each one. Pay attention to the quoted mortgage rates, as well as the various lender fees and closing costs.
There are five main types of mortgages:
A mortgage annual percentage rate (APR) represents the total cost of borrowing a mortgage (interest rate plus closing costs and fees), and is expressed as a percentage. A mortgage interest rate — which is also expressed as a percentage — is the base rate you’re charged to borrow your loan.
You should choose a mortgage lender that best suits your financial needs, which is why it’s crucial to shop around. Make sure the lenders you’re choosing from offer the mortgage program you’re interested in, and ask questions to better understand what to expect from your potential relationship with each lender.
As mentioned above, compare interest rates and closing costs before making a decision.
Once you’ve selected your lender and are moving through the mortgage application process, you and your loan officer can discuss your mortgage rate lock options. Rate locks can last between 30 and 60 days, or even more — if your loan doesn’t close before your rate lock expires, expect to pay a rate lock extension fee.
You’ll need to apply for mortgage preapproval to get an estimated loan amount you could qualify for. Lenders use the preapproval process to review your overall financial picture — including your assets, credit history, debt and income — to calculate how much they’d be willing to lend you for a mortgage.
You can use the loan amount printed on your preapproval letter as a guide for your house hunting journey. But, be careful not to stretch your budget too thin and borrow to the maximum — your preapproval amount doesn’t factor in recurring bills that aren’t regularly reported to the credit bureaus, such as gas, cellphones and other utilities, so you’ll need to retain enough disposable income to comfortably cover these monthly bills, plus your new mortgage payment.
A discount point — also called a mortgage point — is an upfront fee paid at closing to reduce your mortgage rate. One point is equal to 1% of your loan amount. So if you’re borrowing $300,000 for example, one point would cost you $3,000.
Each mortgage point can lower your rate 12.5 to 25 basis points, which equals 0.125% to 0.25%.
It’s possible to negotiate a lower interest rate. Use your mortgage offers as leverage and ask each lender about matching your lowest-quoted rate. You should also consider making a larger down payment and paying for mortgage points.
A 30-year fixed-rate mortgage is the most popular type of mortgage because of its affordability and stability. Meanwhile, the 15-year fixed-rate mortgage typically comes with a lower interest rate when compared with a 30-year loan. The trade-off with a 15-year term is a significantly higher monthly payment, however, because your repayment term is cut in half.
The 5/1 adjustable-rate mortgage (ARM) can be similar to the 30-year fixed-rate mortgage in that it can also have a 30-year repayment term, but there are terms available. What sets 5/1 ARMs apart is that the interest rate is only fixed for the first five years of the term, and then the rate is recalculated annually for the remaining 25 years.
Mortgage rates on 5/1 ARMs are often lower than rates on 30-year fixed loans. When the rate starts adjusting after the fixed period ends, it could go up or down. If your rate increases, you’ll need to be financially prepared to either absorb a higher monthly payment amount or refinance into a fixed-rate mortgage.
A 10/1 adjustable-rate mortgage has a longer, initial fixed-rate period than a 5/1 ARM. You’d enjoy a stable interest rate for the first 10 years and have a fluctuating rate for the remaining 20 years. An 10/1 ARM might work best for you if you plan to sell your home or apply and qualify for a refinance before the fixed-rate period ends.